bailouts

I agree with most of what Stan and Pete have already posted. Paul Krugman nicely pointed out the obvious: " ... California has immense human and financial resources. It should not be in fiscal crisis ..." California's current predicament has been caused by its self-imposed political dysfunction.

There are plenty of resources in California to tax to pay for the state's budget. If the California legislature is unable to raise the needed revenue or cut the excess spending beyond the revenue it can raise, then the governor may have to go hat in hand to Washington. What should he find when he gets there? A firm response that a precondition for any special assistance in the short term is a set of fiscal changes that ensure that there will be more than enough money in the state's general fund to pay back the money, at a high rate of interest, over the long term.

Pete has nicely summarized the history of the ongoing budget situation in California and state and local government bailouts in general.

But Pete missed the most important point as he retold the important story about Alexander Hamilton: the move was also intended to show the bond market of its time that the new United States government was worthy of its confidence...and its money. Hamilton was convinced that no one would lend to the new U.S. if it didn't assume the debts of the colonies and instead repudiated them as being someone else's responsibility.

That's the real lesson here: The state of California may be a government with an economy larger than most countries, but since 1850 it has been part of the U.S. A default in California will have disastrous effects not just there and in the other 49 states, but also for every county and municipal government that borrows and, inevitably, for the United States itself. Some governments will be unable to borrow at all. Those that are able to borrow will be required to pay much higher interest rates for the privilege.

Bailing out states is not new. In 1790, Alexander Hamilton bailed out the New England states following the Revolutionary War by having the federal government assume the debt of the states. New England states had born a disproportionate share of the costs of the war, and Hamilton cleverly bought off the southern states by giving them the capital. The plan worked so well in restoring our young country's credit that fiscal policy experts still study its lessons. Wikipedia has an excellent article on it.

No state has gone bankrupt, but New York City famously became insolvent when it couldn't roll over its debt in 1975, although technically it wasn't a bankruptcy. Up until then, City leaders kept increasing spending until creditors wouldn't lend to them anymore. In 1976 and 1978, Congress revamped Chapter IX of the U.S. Bankruptcy Act of 1898 to provide for an orderly renegotiation of New York City's debt. The GAO report on this makes sobering and familiar reading.

This horror movie keeps getting worse. This morning's New York Times details how Citigroup, under CEO Charles O. Prince III and Robert E. Rubin, took on too much risk in search for every growing profits, only to find the whole enterprise crashing down around them when those risks proved excessive.

What's ahead? My Washington banking sources expect a backdoor nationalization of Citigroup, possibly before 6 p.m. today, when Asian financial markets are poised to hammer Citi stock from $4 to far less 90 minutes from now. That after Citi fell from a 52-week high of $35 in early December, 2007, to its Friday close of $4.